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Addressing the Paradox of Deceased Borrowers

This piece originally appeared in the February 2023 edition of DS News magazine, online now.

Texas is viewed in mortgage servicing circles as having one of the fastest foreclosure processes in the country. In most cases, that’s accurate. For the vast majority of nonjudicial foreclosures, the entire process can be completed within 60-90 days. Compared to the year or more that is often required in some states, the Texas foreclosure process is downright quick. However, when a borrower passes away before the underlying mortgage obligation has been satisfied, servicers often find themselves unable to foreclose or otherwise enforce their contractual rights for months, and in some cases, years. When we talk to default servicing clients, it’s not uncommon to hear that “we don’t have too many issues in Texas … except for deceased borrower foreclosures.” That perception is certainly a reality for many servicers and is rooted in a few nuanced principles and a body of case law that has developed over the past century.

There are a couple undisputed legal principles that create a paradox for servicers when a borrower has passed away. The first principle is that debt is not inherited. Upon an individual’s death, outstanding debts of the deceased are not inherited by the heirs. The debt becomes part of the deceased individual’s “estate.” The estate comes into existence at the moment of death, regardless of any further legal action taken, and includes all the decedent’s property. Any obligations that the deceased had in the moment before death immediately become obligations of the estate … but not obligations of the heirs.

The second principle is that the beneficial interest in estate property immediately passes to the heirs at the moment of death. When a person dies, the beneficial interest in all of decedent’s property passes immediately to: (1) the decedent’s heirs, if there is no will (intestate), or (2) the devisees named in a valid will of the decedent (testate). An heir or “distributee” is any person who is entitled to receive a distribution from the estate, whether under the statutes of descent and distribution or a lawful will. The heirs or distributes may become vested with legal title to the property through a probate administration.

Together, these two principles define the paradox: mortgage debt is not inherited by the heirs, but the heirs are immediately vested with a beneficial interest in the real property encumbered by that mortgage debt. Stated differently, the heirs inherited real property subject to a mortgage debt they do not owe. Yet, the security interest in the real property remains unaffected. It is through administration of the decedent’s estate that the paradox can be reconciled (by satisfying the mortgage obligation and passing clear, legal title to the heirs).

In addition, the Texas Estates Code provides for a four-year period within which the heirs may reconcile the paradox. Specifically, the code provides that any “interested person” may file an application to commence an administration at any point before the fourth anniversary of an individual’s death. This allows the heirs or distributees a four-year window from the date of death to initiate an administration, acquire legal title to the estate property and satisfy any obligations of the estate.

Because of this legal framework, foreclosure of real property when a borrower has passed away isn’t necessarily a legal problem for the servicer. It is a practical problem. For more than 100 years, Texas courts have consistently held that a properly conducted nonjudicial foreclosure within four years of a borrower’s death is a perfectly legitimate sale. It is sufficient to pass legal title to the foreclosure sale purchaser. The power of sale contained within a deed of trust is not suspended merely by virtue of the death of the borrower. However, there’s a catch. The Texas Supreme Court has made it crystal clear that if a nonjudicial foreclosure sale takes place within the four-year period, that sale will be voided at the request of a dependent administrator should an administration be timely commenced.

That is the practical problem for the servicer whose borrower has recently passed away. The servicer is perfectly within its legal rights to complete a nonjudicial foreclosure; title conveyed at foreclosure sale is not void. However, it is voidable should an interested party choose to contest it.

And because title acquired through a nonjudicial foreclosure sale is voidable within four years of the borrower’s death, the servicer is effectively unable to liquidate the REO asset. Prospective purchasers are disinclined to purchase real estate knowing that the conveyance could potentially be unwound, and title insurance companies are unwilling to assume the risk that no heirs will step up and initiate a dependent administration.

Now, the death of a borrower doesn’t always automatically mean that the servicer’s enforcement remedies are obstructed for four years. For example, if the borrower passes away after the foreclosure sale, the validity of the sale will not be affected by the subsequent death of the borrower.

Alternatively, if more than four years have elapsed since the borrower’s death with no administration having been commenced, the foreclosure sale is not subject to challenge on the grounds that the borrower is deceased.

Other scenarios that frequently arise include those in which the heirs have initiated an independent or a dependent administration before the servicer contemplates its enforcement remedies.

In the case of a pending independent administration, the nonjudicial foreclosure remedy is still available to the servicer, albeit with additional notice requirements and prescribed timeframes to allow the independent administrator an opportunity to liquidate the asset. In the case of a pending dependent administration, the Estates Code outlines a formal and well-defined process for the servicer to establish its claim, and to seek foreclosure of its lien.

It is the scenario where the borrower has passed away within the last four years, and the heirs have taken no action, that creates the greatest obstacle to servicers attempting to enforce their security interests. This is the scenario wherein the paradox of the beneficial interest passing to the heirs, who have no obligation to satisfy the underlying mortgage debt, can limit the servicer’s practical options. That isn’t to say that there are no options. There are. But the nature of the options available is very fact-specific and will be dictated largely by the particular circumstances of any given case.

When a borrower passes away in Texas, a servicer is presented with a variety of scenarios that may be as complex as they are unique. The paradox inherent in Texas probate law creates challenges and issues for servicers that must be analyzed for each deceased borrower matter based upon its own unique circumstances. There are a multitude of legal and procedural questions that arise beginning on the date of a borrower’s death and may remain unanswered well after the borrower’s death. When the situation arises, a servicer is not limited solely to waiting out a four-year period for probate. There can be a path forward—however, a servicer should proceed cautiously. It would be prudent to consult an attorney in Texas, and a servicer would be well advised to seek guidance from a probate specialist that can investigate and evaluate the status of the estate and provide options and alternatives that best align with your objectives.

About Author: Thuy Frazier

Thuy Frazier is an Associate Attorney and Texas Foreclosure Oversight Counsel with the law firm of McCarthy & Holthus LLP. Frazier has over a decade of experience advising servicing industry clients with a focus on creditors’ rights and a specialty in probate-foreclosure matters in Texas. She is a graduate of the SMU Dedman School of Law in Dallas and completed her undergraduate studies at Baylor University in Waco. As an alumna of the State Bar of Texas Real Estate, Probate, and Trust Law Section’s Leadership Academy, she is active in local and state bar associations encouraging involvement and participation from young lawyers in real estate and creditors’ rights practice areas.

About Author: Cole Patton

Cole Patton is a Managing Partner of McCarthy & Holthus, LLP, and oversees the firm’s Texas and Arkansas practices. Patton has a BBA in finance from Texas Tech University and is a graduate of SMU School of Law. His practice is focused on creditor’s rights, having represented financial institutions in litigation, bankruptcy, and default enforcement matters for more than 20 years. Patton is licensed to practice law in the states of Texas, Mississippi, and Arkansas.
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